The setup is just too juicy.
By Wolf Richter for WOLF STREET.
In my decades of looking at the stock market, there has never been a better setup. Exuberance is pandemic and sky-high. And even after today’s dip, the S&P 500 is up nearly 29% for the year, and the Nasdaq 35%, despite lackluster growth in the global economy, where many of the S&P 500 companies are getting the majority of their revenues.
Mega-weight in the indices, Apple, is a good example: shares soared 84% in the year, though its revenues ticked up only 2%. This is not a growth story. This is an exuberance story where nothing that happens in reality – such as lacking revenue growth – matters, as we’re now told by enthusiastic crowds everywhere.
Until just a couple of months ago, the touts were out there touting negative interest rates soon to come to the US and thus making stocks the only place to be. Those touts have now been run over by reality. Now they’re touting QE4 by the Fed, or whatever. And people were looking for any reason to buy.
The unanimity of it all was astounding. I’ve seen this before, but not in this magnitude.
And there is this: As stocks were surging over the past few months, investors with large gains who wanted to sell didn’t sell before year-end in order to defer that income for tax considerations. So there was reduced selling pressure from that group that would have liked to sell, and that will sell after the new year starts.
So I shorted the stock market today, December 30 – me who is on record of saying repeatedly that I would never ever short anything ever again, after the debacle of November 1999 when I shorted the most obviously ridiculous Nasdaq high-fliers a few months too early. They collapsed to near-zero, but not before ripping off my face.
But I changed my mind. The setup is just too perfect. A year ago, on December 22, 2018, as stocks had been plunging, I wrote, Nothing Goes to Hell in a Straight Line, Not Even Stocks. That turned out to be true – practically nothing goes to hell in a straight line. I expected a bounce. I didn’t expect that the bounce would be this huge. But now it’s part of the setup for shorting the market.
- I sold short the SPDR S&P 500 ETF Trust [SPY] the biggest and most liquid ETF tracking the S&P 500 index. It’s up nearly 29% in 2019, from already wildly overvalued levels a year ago, despite the drop it had gone through.
- And I sold short the Nasdaq 100 Invesco QQQ ETF [QQQ], which tracks the NASDAQ 100, the largest most liquid tech-focused ETF. It’s up 42% in 2019.
I have spoken out against shorting because the risk-reward relationship is out of whack. If you short individual stocks, the maximum gain if the shares go to zero is 100%, while the maximum loss is theoretically unlimited and can easily exceed the entire value of the bet. And betting against stocks by buying put options leads most investors to pay the premium and watch those options expire worthless.
The only way you can short stocks and make money reliably is if you have a large megaphone that is closely followed by algos, traders, and the entire financial media. You quietly take your short position in a stock and then announce it, and algos and traders react, and the shares plunge. That’s the only reliable way to make shorting work.
My little website isn’t followed by algos and can’t move markets or stocks or anything else, and that’s a good thing. I can say whatever I want, and nothing big happens as a result of it.
Shorting is socially frowned upon. It’s like you’re willfully trying to destroy people’s constitutional right to the pursuit of happiness. Back in 2017, NYSE Group President Tom Farley, famously told Congress, “It feels kind of icky and un-American, betting against a company.”
But I still won’t short individual stocks because they can get too crazy – especially Tesla, one of the most obvious shorts with an enormous amount of short interest outstanding. This in itself is practically a guarantee the stock cannot crash because short sellers become buyers to take profits when the price drops enough, and they put a floor under the shares. And the massive short interest makes TSLA prone to violent short-covering rallies.
This stock is a prime example of how crazy the market is. In the US, there were fewer new vehicles sold in 2019 than in 2000. Similarly, in Europe and in Japan. Even formerly booming markets, such as China and India, have now hit the skids in auto sales. For growth, every automaker needs to take market share away from other automakers – a tough game in a no-growth environment.
Tesla’s revenues fell 7.3% year-over-year in the third quarter, a steeper decline than the revenue declines at other US automakers.
At $412 a share, Tesla is valued at $75 billion. This is over three times 12-month revenues ($24 billion).
GM is valued at $52 billion. This is just 0.36 times 12-month revenues ($144 billion). By this measure of the price-to-sales ratio, Tesla, if it ever becomes profitable on an annual basis, is overvalued by a factor of 10 compared to GM.
GM at this price is still a sell, in my view. As for Tesla, in the optimistic scenario that it makes an annual profit of $1 billion, it’s shares would have to drop to $41 before they’re on the same level of overvalued as GM, and both would still be a sell at those levels.
So Tesla at the current price is one of the most obvious shorts in history. But I wouldn’t short the shares because they’re just too crazy, and because the short is too obvious.
Given how eagerly investors are betting on a big plunge, deeply out-of-the-money Tesla put options carry a big premium. For example, one contract (representing 100 shares) that expires in January 2021, with a strike price of $290, which is about 32% below today’s share price, traded today at $2,625 — another sign that Tesla has become one of the most obvious shorts out there. And that takes it off the table for me.
In terms of my SPY and QQQ short positions: they’re trades, not a prediction of where the market will be a year from now. They represent my expectations that the market will drop enough to make this worthwhile over the next few months.
If this math is successful, and I cover those shorts with a gain, it doesn’t mean that I therefore turned bullish on the market. On the contrary. In the larger scheme of things, stocks would have to tank a whole bunch more before I’d take a buy-and-hold position in the overall market. Happy New Year!
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